Importance of Bond Duration

One of the regular risks, interest bearing instruments like bonds are prone to is the interest rate risk, which is the variation in the price of the instrument in relation to the changes in the general interest rates. The concept of 'duration' is the effective way of determining and mitigating the effects of interest rate alternations. It measures the sensitivity of the bond's price to movements in interest rates and determines in how many years a bond shall repay its true cost.

Duration of a bond is usually calculated as a percentage reduction in the price of the instrument to the percentage increase in the redemption yield of the instrument. The unit of duration is generally measured in 'years' and ranges between 0 years and the maximum maturity of the bond.

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Steps to Calculate Duration:

• Coupon rate determination.

• Determining PV (Present Value) factor using the yield per period.

• Then PV factor is to be multiplied with coupon amount to arrive at the PV value of the coupon payment.

• The aggregate of the present value of cash flows is arrived to determine the market value of the bond.

• For each year, the percentage of present value in total market is arrived. (step 3 / step 4).

• The resultant figure is multiplied with the year and the aggregate amount is the duration.

Factors influencing duration are usually the bond's maturity time and the coupon rate. A bond maturing in 2 years recovers its cost in quicker time as compared to a bond maturing in 10 years. Hence, duration varies as per the maturity, shorter maturity has lower duration and similarly longer maturity has higher duration. Coupon rate also is a key factor in determining the cost recovering period of the bond. A higher coupon bond return the cost in quick time compared to a lower coupon bond. Hence, higher coupon bonds have lower duration and lower coupon bonds have higher duration.

Duration guides investors in choosing the bond as per their risk appetite. Investors seeking quick cost recovery and minimal sensitivity to interest changes can use the concept of duration and also speculators anticipating changes in interest rates can adjust their portfolios.

Importance of Bond Duration

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The Importance of Budgeting - Planning Your Financial Present and Future

Budgeting is about planning your financial present and future. It is one of the most important steps to take on your financial journey and is an integral part of financial planning.

Planning entails setting some goals to aim for in the future. Whether your goal is to save more or pay off debt, or perhaps both, you need to understand your spending habits.

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In order to understand your spending habits take one of the following steps:

Research past bank statements and receipts. While this is time-consuming it is eye-opening...or Record all of your spending over the next month or so in a small notebook. This means recording everything from bills to cash spending. Once again a surprise is likely to be in store.

Set your budget and include savings (for the future) or to pay-off debt goals (the present). A budget is not merely a spreadsheet that tracks how much you spend for the month and it is not just balancing tool. While both of these are both important, neither fits the meaning of living within a budget -- your spending habits will control that.

Your present expenses are those that are needed for day-to-day living. These include essential expenses such as accommodation costs of rent or mortgage. It includes payment of debt and your utility costs as well as food and groceries. Some expenses are fixed in that they do not change each month while others vary from month to month. Having your present spending requirements fit within your income will mean living without getting yourself into uncontrolled debt. A budget is essential to know that you are living within your means.

Once you have determined how much money you have after paying all your essential monthly expenses, set aside a portion to save for your future expenses. You have no doubt heard the adage 'pay yourself first'. The idea is to put 10% of all income into long-term investment for your future -- this is considered the ideal percentage. Pay yourself as part of your essential spending and make it a habit.

Expenses for your future involve putting money aside for your goals: buying a house, saving for children's education, holidays and retirement to name a few. Each goal will have an amount to save for in your budget. Open a savings account specifically for your goals and transfer a set amount to that account every time you get paid. Making it automatic makes it a habit and tends not to be missed after a while...and it will gradually build up a sizable sum. When you are ready to spend on your goal you will already have the money set aside.

The importance of budgeting is living within the limits of your income and sticking to spending goals. This can be very rewarding, emotionally and financially. Planning your financial present and future depends on a good budget.

The Importance of Budgeting - Planning Your Financial Present and Future

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